I would like to share my personal experience that is the best example of how anchoring bias works, manipulating investors’ psychology.
Few months ago I was shopping for a shirt and found one with a price tag of Rs. 1000. Though the shirt was very nice, I thought it was expensive and decided not to buy.
Few weeks later, I was in the same shop again and came across the same shirt, but this time, it was on sale. So instead of a simple Rs.1,000 price tag, the new price tag was Rs.1,200, but was being offered at a discount for Rs.1,000.
The owners of the shop played smart and created a psychological anchor in the mind of the customers that the actual cost of the shirt was Rs.1,200 but was available at a discount.
The customers were lead to think it’s a great deal (in reality there was no change except the price tag) and bought the shirt right away.
Anchoring bias uses a focal point as a reference for its decision making. In the case above, the shop owner used price tag as a focal point and created an illusion of discount in the mind of the customer, leading them to believe that the shirt is at a discount.
Similar biases exist in stock market as well. Every investor has a price at which he thinks the stock is attractive. When the prices go down, investors still hold to the stock in a bias that it will come up to their purchase price. Because of this bias, they keep holding a losing stock, suffering losses.
The solution to this bias is to keep tracking the changes in the underlying fundamentals of the company and align them to the changes in price.
A stock with deteriorating fundamentals is not a great investment even if its trading at lower valuation. Tracking fundamentals of the company along with price movement will help you get a clear perspective on the stock.